The Corner

Flirting With Disaster

The Daily Telegraph’s Ambrose Evans-Pritchard reports on some financial analysts’ response to the possibility of a US default. Here’s an extract.

Andrew Garthwaite from Credit Suisse said a default would be catastrophic, causing 5pc contraction in the US economy and a 30pc drop on Wall Street, with “massive” ramifications for the world.

“It is almost unthinkable to believe the US would miss a coupon payment [$29bn are due on August 15]. If the US does default, the repo market would probably cease to work. It is hard to imagine money market funds operating under this scenario. The inter-bank market would freeze up. The fallout would be far worse than after Lehman’s default,” he said. “It would be horrible to think what happens to the dollar if the Fed hints it would offset the growth damage with QE3.”

Mr Garthwaite said it might not be that much better if the US fails to lift the debt ceiling and enacts a draconian fiscal squeeze equal to 11pc of GDP (annualised) to stave off default. Such an outcome would at first lead to a 10pc to 15pc drop in equities and a fall in 10-year Treasury yields to 2.75pc. The dollar would slide. The longer it went on, the worse it would be. Each month would mean fiscal tightening equal to 0.9pc of GDP.

Some experts fear that variants of this scenario would spiral out of control. It would drive a string of US states and municipalities into bankruptcy if it lasted more than a few weeks, while the multiplier effect would tip the economy into a self-defeating downward spiral with echoes of 1931.

There’s plenty more where that comes from, but note, in particular, this:

Fathom Consulting said the twin debt crises in the US and Europe risk feeding on each other in a dangerous synergy unless leaders get a grip quickly. “We are on the brink of a major sovereign debt crisis: the latest European bail-out package has done next to nothing to alter that view,” said the group.

Wall Street forecasts are famously fallible, but are these theses ones that we even want to be testing?

Underlining this point: (via CNBC)

The debt impasse in Washington has some concerned about cash moving out money market funds and in turn, creating stress in the short-term liquidity market. There are signs of stress appearing in the commercial paper market and it appears to be related to the redemptions being experienced by the money market funds,” says David Greenlaw, Morgan Stanley’s Chief U.S. Fixed Income Economist. “It’s creating a liquidity shortfall in the commercial paper market.” Left unchecked, he says could lead to a liquidity squeeze in the commercial paper markets.

That’s not what businesses (or those who work for them) should want to hear.

And while we are on the topic of Main Street, I read with interest a comment in one newsletter (the Gartman Letter) that the author’s clients in the trucking business are telling him that their business had, after a good run, “hit the proverbial wall and in some instances have fallen off the edge of that wall.”

Anecdotal, sure, but…

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